IMF Mission Concludes the 2013 Article IV Consultation with Japan

An International Monetary Fund (IMF) team, led by Mr. Jerald Schiff, Deputy Director for the Asia and Pacific Department, visited Tokyo during May 21 - 31 to conduct the annual Article IV discussions with Japan. The team met with senior officials from the government, the Bank of Japan (BoJ), and private sector representatives, to discuss recent economic developments and the policy agenda going forward. Mr. David Lipton, the IMF's First Deputy Managing Director, and Mr. Anoop Singh, Director for the Asia and Pacific Department, joined the final policy discussions. At the conclusion of the visit, the mission issued the following statement:

“The economic recovery is gaining traction, driven in large part by the adoption of the new Quantitative and Qualitative Monetary Easing (QQME) framework. The success of the authorities’ new policies (“the three arrows”) depends crucially on the implementation of ambitious fiscal and growth reforms, with initial plans in these areas to be unveiled this summer. The rewards of a complete package of reforms are potentially large. Successful implementation would not only benefit Japan, but also strengthen growth and stability of the global economy.

“The new policies have gotten off to a promising start. Growth in the first quarter of 2013 rebounded strongly, led by consumption and net exports, and growth is projected to reach 1.6 percent for the year as a whole. Because of the rising impetus of private demand, growth in 2014 will slow only moderately to 1.4 percent despite fiscal consolidation resulting from the planned consumption tax increase and the unwinding of reconstruction spending.

“We fully endorse the BoJ’s sweeping enhancements to its monetary policy framework. By setting a clear time frame for achieving 2 percent inflation underpinned by a large-scale expansion of asset purchases, the BoJ has taken an important step for raising growth and inflation. Initial signs suggest that the new monetary framework is beginning to work. Indicators from household and business surveys, and from breakeven inflation rates all suggest a gradual pickup in inflation expectations, albeit still well below the inflation target.

“Consistent with the new policy objectives, the BoJ is also taking appropriate steps to contain excessive volatility in the government bond market, including by realigning asset purchases and enhancing communication with market participants. Complementary growth strategies and fiscal reforms are, however, essential to raise inflation in a durable manner. If these are successfully implemented, the mission estimates that the 2 percent inflation target could be achieved in the near to medium-term.

“Fiscal risks have risen as additional stimulus and social security spending have added to the public debt. A concrete and credible medium-term fiscal plan should be adopted as quickly as possible. Staff estimates that over the next decade, structural fiscal consolidation of 11 percent of GDP is needed to put the debt-to-GDP ratio firmly on a declining path.

“Raising the consumption tax rate as scheduled to 10 percent by 2015 is an essential first step and together with waning stimulus and reconstruction spending contributes to about half of the needed adjustment. Introducing multiple consumption tax rates should be avoided. Instead, targeted support for low-income households could be considered. Beyond 2015, the remaining 5½ percent of GDP of adjustment needs to be identified. Fiscal consolidation could be achieved through a mix of expenditure and revenue measures, but emphasis should be put on growth-friendly measures. Because the consumption tax is the most efficient revenue source, further increases over time to 15 percent or more should be considered.

“To raise growth over the medium-term, structural reforms are critical. The government’s participation in the Trans-Pacific Partnership negotiations and its plans to raise the employment of women are important steps in this direction. But a broader effort is needed to generate growth synergies. Further measures include deregulation in agriculture and domestic services, encouraging the provision of risk capital for start-ups while phasing out costly government support for unviable SMEs. Reducing Japan’s excessive labor market duality will increase flexibility. Also, further relaxing entry requirements for high-skilled foreign workers could strengthen labor supply in areas where there are shortages.

“Japanese banks’ JGB holdings can decline in the next two years as QQME leads to a transfer of JGBs from bank balance sheets to the BoJ. In turn, this could reduce the sensitivity of bank balance sheets to interest rate shocks and allow them to extend more credit at home and abroad and raise profitability. But there are also risks, particularly for regional banks if fiscal and growth reforms disappoint and credit demand stays subdued. Strengthening capital standards of domestic banks and encouraging stronger risk-management should be considered. The overseas expansion by major banks will likely go forward and efforts to mitigate foreign exchange funding risks should continue.

“The recent large depreciation of the yen must be understood in the context of the critical and welcome effort of the BoJ to decisively exit from deflation. So long as monetary easing pursues domestic goals, and is accompanied by comprehensive fiscal and structural reforms, we do not see the yen's recent depreciation as problematic.

Over time, a successful package of reforms would have positive economic spillovers. Although near-term effects in other countries could be more mixed, particularly for some direct competitors or countries receiving capital inflows, these would be likely temporary. Higher growth in Japan and easier global financial conditions would more than offset the effect of exchange rate appreciation and generate positive spillovers.”